Cigna Turnaround Could Be Years Away

The company's profit warnings chop $4 billion out of its market cap.
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A profit warning from

Cigna

(CI) - Get Report

lopped almost $4 billion off its market value Friday as investors worried it could be years before the health insurer emerges from its recent troubles.

Shares of the No. 3 U.S. health insurer skidded 42% to $36.83 Friday, dragging other HMO stocks down with them. The Morgan Stanley Health Payer Index fell 2% to 565, although analysts said Cigna's competitors aren't likely to repeat their dismal performance.

Cigna now expects to earn far less than analysts had projected for the third quarter and full year of 2002 and all of 2003 because it did not hedge appropriately for higher medical costs. Many insurers negotiate premiums months in advance, and that means companies tend to be exposed if medical expenses rise faster than expected.

Litany of Troubles

Cigna cited a slew of other reasons for the profit shortfall, including higher spending relative to membership levels and even the weakness in the stock market.

What concerns analysts most is the time it will likely take for Cigna to restructure its business and rein in costs. Some note that it is too late to implement corrective pricing actions for next year, because most members have already renewed their 2003 policies.

In its press release late Thursday, Cigna said it is pursuing a major realignment of its organizational structure and staff, which should result in better management of health care expenses, enhanced customer focus and cost savings.

"Cigna is about to enter a period of transition that will not be easy, nor will it be quick," said Lehman Brothers analyst Joshua Raskin.

Raskin said it typically takes about 11 quarters for managed care firms to turn around, while the average loss of membership amounts to about 24%. "Hypothetically, that would suggest that Cigna's first membership-gain quarter will come in the third quarter of 2004, with membership at about 10.87 million," he said.

The possibility of additional charges is also worrying. In the third quarter, Cigna took $1 billion in charges from its now-defunct reinsurance business, and Raskin expects similar charges to be taken in the fourth quarter. "To put that in perspective, $1 billion represents almost 20% of shareholders' equity and over five quarters of net income," he added.

Unknown Costs

Goldman Sachs analyst Matthew Borsch is equally concerned, noting that while Cigna has "a long history, solid reputation and valuable business franchise," it also requires "a multiyear turnaround at unknown cost."

Still, Borsch does believe that Cigna's problems are company-specific, "resulting from underpricing that may result from systems problems." The outlook for the large, well-run companies remains very positive, he said, citing strong results from

UnitedHeath Group

(UNH) - Get Report

,

Aetna

(AET)

,

Oxford Health Plans

(OHP)

and

WellPoint

(WLP)

in the third quarter.

CIBC World Markets analyst John Szabo agrees with this view and actually upgraded shares of Aetna in light of Cigna's news Friday. "Nearly every other managed care company has reported record earnings this year," he said.

As for Cigna, it said it will earn about $205 million, or $1.47 a share, in the third quarter, excluding more than $1 billion of charges. Last month, Cigna said it expected to earn between $1.90 and $2.05 a share for the quarter, and analysts had been expecting earnings of $1.99 a share. The company also slashed its year-end profit forecast to between $6.50 and $6.75 per share, down from $7.85 to $8, and subsequently lowered 2003 guidance to between $6.25 and $6.50 per share, down from analysts' forecast of $8.84.

In addition, Cigna noted that weak equity markets have pressured its pension plans, meaning it will have to increase its minimum pension liability in the fourth quarter. That will likely reduce shareholder equity by about $600 million to $700 million.

Analysts slashed their 2002 and 2003 estimates on the stock Friday and suggested that the company will need to tap the capital markets for financing. In a prior announcement, Cigna has stated that it would need to raise several hundred million dollars though public market offerings.

"CI clearly has franchise value, as well as some coveted assets, but the potential need for external financing may make it difficult to realize

the full value of these assets," Szabo said.

Cigna is scheduled to report third-quarter earnings Nov. 1.